Financial
Policy DespairBy PAUL KRUGMAN
Published: March 22, 2009

New York Times - Over the weekend The Times and
other newspapers reported leaked details about the Obama administration’s
bank rescue plan, which is to be officially released this
week. If the reports are correct, Tim Geithner, the Treasury
secretary, has persuaded President Obama to recycle Bush administration
policy — specifically, the “cash for trash”
plan proposed, then abandoned, six months ago by then-Treasury
Secretary Henry Paulson.

This is more than disappointing. In fact, it fills me with
a sense of despair.

After all, we’ve just been through the firestorm over
the A.I.G. bonuses, during which administration officials
claimed that they knew nothing, couldn’t do anything,
and anyway it was someone else’s fault. Meanwhile, the
administration has failed to quell the public’s doubts
about what banks are doing with taxpayer money.

And now Mr. Obama has apparently settled on a financial plan
that, in essence, assumes that banks are fundamentally sound
and that bankers know what they’re doing.

It’s as if the president were determined to confirm
the growing perception that he and his economic team are out
of touch, that their economic vision is clouded by excessively
close ties to Wall Street. And by the time Mr. Obama realizes
that he needs to change course, his political capital may
be gone.

Let’s talk for a moment about the economics of the
situation.

Right now, our economy is being dragged down by our dysfunctional
financial system, which has been crippled by huge losses on
mortgage-backed securities and other assets.

As economic historians can tell you, this is an old story,
not that different from dozens of similar crises over the
centuries. And there’s a time-honored procedure for
dealing with the aftermath of widespread financial failure.
It goes like this: the government secures confidence in the
system by guaranteeing many (though not necessarily all) bank
debts. At the same time, it takes temporary control of truly
insolvent banks, in order to clean up their books.

That’s what Sweden did in the early 1990s. It’s
also what we ourselves did after the savings and loan debacle
of the Reagan years. And there’s no reason we can’t
do the same thing now.

But the Obama administration, like the Bush administration,
apparently wants an easier way out. The common element to
the Paulson and Geithner plans is the insistence that the
bad assets on banks’ books are really worth much, much
more than anyone is currently willing to pay for them. In
fact, their true value is so high that if they were properly
priced, banks wouldn’t be in trouble.

And so the plan is to use taxpayer funds to drive the prices
of bad assets up to “fair” levels. Mr. Paulson
proposed having the government buy the assets directly. Mr.
Geithner instead proposes a complicated scheme in which the
government lends money to private investors, who then use
the money to buy the stuff. The idea, says Mr. Obama’s
top economic adviser, is to use “the expertise of the
market” to set the value of toxic assets.

But the Geithner scheme would offer a one-way bet: if asset
values go up, the investors profit, but if they go down, the
investors can walk away from their debt. So this isn’t
really about letting markets work. It’s just an indirect,
disguised way to subsidize purchases of bad assets.

The likely cost to taxpayers aside, there’s something
strange going on here. By my count, this is the third time
Obama administration officials have floated a scheme that
is essentially a rehash of the Paulson plan, each time adding
a new set of bells and whistles and claiming that they’re
doing something completely different. This is starting to
look obsessive.

But the real problem with this plan is that it won’t
work. Yes, troubled assets may be somewhat undervalued. But
the fact is that financial executives literally bet their
banks on the belief that there was no housing bubble, and
the related belief that unprecedented levels of household
debt were no problem. They lost that bet. And no amount of
financial hocus-pocus — for that is what the Geithner
plan amounts to — will change that fact.

You might say, why not try the plan and see what happens?
One answer is that time is wasting: every month that we fail
to come to grips with the economic crisis another 600,000
jobs are lost.

Even more important, however, is the way Mr. Obama is squandering
his credibility. If this plan fails — as it almost surely
will — it’s unlikely that he’ll be able
to persuade Congress to come up with more funds to do what
he should have done in the first place.

All is not lost: the public wants Mr. Obama to succeed, which
means that he can still rescue his bank rescue plan. But time
is running out.

Comments

This is more than disappointing. In fact,
it fills me with a sense of despair.

After all, we’ve just been through
the firestorm over the A.I.G. bonuses, during which administration
officials claimed that they knew nothing, couldn’t do
anything, and anyway it was someone else’s fault. Meanwhile,
the administration has failed to quell the public’s
doubts about what banks are doing with taxpayer money.

And now Mr. Obama has apparently settled
on a financial plan that, in essence, assumes that banks are
fundamentally sound and that bankers know what they’re
doing.

It’s as if the president were determined
to confirm the growing perception that he and his economic
team are out of touch, that their economic vision is clouded
by excessively close ties to Wall Street. And by the time
Mr. Obama realizes that he needs to change course, his political
capital may be gone.

Let’s talk for a moment about the
economics of the situation.

Right now, our economy is being dragged
down by our dysfunctional financial system, which has been
crippled by huge losses on mortgage-backed securities and
other assets.

As economic historians can tell you, this
is an old story, not that different from dozens of similar
crises over the centuries. And there’s a time-honored
procedure for dealing with the aftermath of widespread financial
failure. It goes like this: the government secures confidence
in the system by guaranteeing many (though not necessarily
all) bank debts. At the same time, it takes temporary control
of truly insolvent banks, in order to clean up their books.

That’s what Sweden did in the early
1990s. It’s also what we ourselves did after the savings
and loan debacle of the Reagan years. And there’s no
reason we can’t do the same thing now.

But the Obama administration, like the
Bush administration, apparently wants an easier way out. The
common element to the Paulson and Geithner plans is the insistence
that the bad assets on banks’ books are really worth
much, much more than anyone is currently willing to pay for
them. In fact, their true value is so high that if they were
properly priced, banks wouldn’t be in trouble.

And so the plan is to use taxpayer funds
to drive the prices of bad assets up to “fair”
levels. Mr. Paulson proposed having the government buy the
assets directly. Mr. Geithner instead proposes a complicated
scheme in which the government lends money to private investors,
who then use the money to buy the stuff. The idea, says Mr.
Obama’s top economic adviser, is to use “the expertise
of the market” to set the value of toxic assets.

But the Geithner scheme would offer a one-way
bet: if asset values go up, the investors profit, but if they
go down, the investors can walk away from their debt. So this
isn’t really about letting markets work. It’s
just an indirect, disguised way to subsidize purchases of
bad assets.

The likely cost to taxpayers aside, there’s
something strange going on here. By my count, this is the
third time Obama administration officials have floated a scheme
that is essentially a rehash of the Paulson plan, each time
adding a new set of bells and whistles and claiming that they’re
doing something completely different. This is starting to
look obsessive.

But the real problem with this plan is
that it won’t work. Yes, troubled assets may be somewhat
undervalued. But the fact is that financial executives literally
bet their banks on the belief that there was no housing bubble,
and the related belief that unprecedented levels of household
debt were no problem. They lost that bet. And no amount of
financial hocus-pocus — for that is what the Geithner
plan amounts to — will change that fact.

You might say, why not try the plan and
see what happens? One answer is that time is wasting: every
month that we fail to come to grips with the economic crisis
another 600,000 jobs are lost.

Even more important, however, is the way
Mr. Obama is squandering his credibility. If this plan fails
— as it almost surely will — it’s unlikely
that he’ll be able to persuade Congress to come up with
more funds to do what he should have done in the first place.

All is not lost: the public wants Mr. Obama
to succeed, which means that he can still rescue his bank
rescue plan. But time is running out.Jon Amsden, Ph.D